Before disallowance of salary u/s 40A(2)(b) AO duty bound to provide an opportunity

Before disallowance of salary u/s 40A(2)(b) Assessing Officer was duty bound to provide an opportunity to the assessee to place on record the requisite evidence.

ABCAUS Case Law Citation:
ABCAUS 3811 (2023) (10) HC

In the instant case, the assessee had challenged the order passed by the ITAT in inter alia confirming disallowance of salary by the Assessing Officer (AO) by taking recourse to Section 40A(2)(b) of of the Income Tax Act, 1961 (the Act).

For the relevant Assessment Year the Assessing Officer had held that the

assessee had debited an handsome amount of salary paid to few persons which was covered under Section 40A(2)(b) of the Act despite there being a decline in the business during the relevant Financial Year and that there was no justification presented by the appellant/assessee in that regard. Therefore, the AO disallowed the difference between the salary paid to those persons in earlier years.

The CIT(A) considered the salary component item wise and allowed the salary paid to two persons at rate per month he considered commensurate with their academic qualification and nature of responsibility discharged by them during the relevant year, but as regards the salary paid to two other persons, sustained the additions made by the Assessing Officer on the ground that the turnover of the assessee company during the relevant year had come down heavily and the assessee had failed to substantiate with evidence, services if at all rendered by them or their justifiability. With respect to one person he allowed the same on the ground that the said person was found entrusted with jobs involving collection rent, deposit of rent cheques with the banks, following up on service tax, supervising the office personnel, looking after the companies machinery etc. With respect to another person, CIT(A) sustained the additions made by the Assessing Officer on the ground that the appellant/assessee could not substantiate the nature of work done by her.

The Tribunal simply recorded the above findings of the CIT(A) and expressed agreement with the same without adding their independent arguments/findings.

Before the Hon’ble High Court the assessee contended that the order impugned was not sustainable in the eyes of law because the appellant had described in detail circumstances under which no salary was paid to the four related persons concerned earlier Financial Years and the circumstances under which a meagre salary was paid to them for subsequent years relevant for present purposes.

To justify the payment of salary to the persons concerned, assessee also filed a detailed profile of the said persons including their educational qualifications, experience and job contribution in the business of the assessee company.

On the other hand, revenue supported the impugned orders and submitted that since the appellant/assessee led no evidence in support of its contentions, there was no illegality in the impugned order.

The Hon’ble High Court observed that there was no dispute that the four persons, were persons covered under Section 40A(2)(b) of the Act. However, as reflected from records, the appellant/assessee was not granted fair opportunity to lead evidence in order to prove its justification for payment of salaries to the said persons.

The Hon’ble High Court observed that the provision under Section 40A(2)(a) of the Act clearly shows that before recording disallowance, the Assessing Officer has to form an opinion; and that opinion has to be having regard to inter alia legitimate needs of the business or benefit derived or even what would be the fair payment outgo for services rendered. Such an opinion cannot be arrived at without adducing necessary evidence.

The Hon’ble High Court opined that the Assessing Officer was duty bound to provide an opportunity to the assessee to place on record the requisite evidence to justify its claim. But all that the Assessing Officer did was to ask the appellant/assessee to justify the salaries paid, and without seeking relevant evidence, simply rejected claim.

The Hon’ble High Court aside the impugned order and remanded the matter to the Assessing Officer with liberty to the assessee to adduce evidence. Accordingly, the question of law framed above was decided in favour of assessee and against revenue.

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